FAST MONEY AND FRAUD
By Allen Pusey, The Dallas Morning News, 4/23/1989ON THE STRETCH OF INTERSTATE 30 THAT LINKS Dallas to Lake Ray Hubbard, about 19 miles away, Dallas County is a work of urbanization still in progress.
Here, there are no tinted towers, glitzy high-rise rehabs or tony supper clubs. Instead, there are condominiums. Thousands of them. Row upon row upon row. Some are inhabited, lined with the banners of bankrupt real estate ("Now Leasing! No Deposit! Six Weeks Free!"). Others are dark and deserted, with windows of cardboard or no windows at all. Still others are dilapidated and skeletal. And even where there are no condos, there are slabs for condos: flat concrete gravestones for a building boom that died five years ago.
This is not a place one would associate with the go-go times of Texas savings institutions. Gone are the helicopters from the powder-blue helipad on Lake Ray Hubbard and the fleet of Rolls-Royces and Mercedes-Benzes parked outside the nearby Wise Circle Grill. But it was here - on this I-30 condo corridor between the bedroom communities of Garland and Mesquite - that Federal regulators got their first whiff of the disaster brewing in the nation's thrifts.
According to court records, these condominiums and slabs of condominiums were the end product of a massive land-investment scam engineered by a small network of savings institutions headed by the Empire Savings and Loan Association of Mesquite. At Empire, a handful of local developers - captained by D. L. (Danny) Faulkner, a former house painter turned condominium developer - relieved the nation's thrift system of more than $500 million in what one Federal regulator called "one of the most reckless and fraudulent land-investment schemes" his agency had ever seen.
When Empire was closed by Federal regulators on March 14, 1984, it was the first closing openly attributed to fraud in the 50-year history of the federally insured thrift system. So far, more than 100 people have been convicted for their involvement in the scheme.
On the day Empire was shut down, its chairman, Spencer H. Blain Jr., was banned from the savings and loan business. In April 1987, Blain settled a civil racketeering suit with the Federal Savings and Loan Insurance Corporation (F.S.L.I.C.) for $100 million.
Danny Faulkner as well as Blain and five other key figures - said by Federal prosecutors to have made a total of $112 million in bogus condominium deals financed by Empire loans - are on trial in Lubbock, Tex., on racketeering and conspiracy charges. Clifford Sinclair, a Faulkner associate, has been sentenced to 13 years in prison and he plans to testify against Faulkner and the others. Those on trial plan to place much of the blame for fraud at Empire on Sinclair.
The Federal charges center on the relationship among Faulkner; his partner, James L. Toler, and Blain. Through Blain, the Government contends, Faulkner and Toler essentially controlled lending at Empire, though neither held any post at Empire nor any significant stock. None of the accused deny making substantial money from the I-30 condominium deals, or that widespread fraud took place in connection with the Empire loans. But each denies having done anything illegal. The fraud, they say, was committed by others who had worked for them.
Today, the $279 million Federal deposit insurance payout at Empire pales beside other thrift losses and failures. The 1986 closing of just one Texas institution, for instance, cost $1.3 billion. In the five years since Empire was shut down, about 500 of the nation's savings institutions have been closed or merged, or are scheduled to be closed or merged, by regulators.
The bailouts have bankrupted F.S.L.I.C., which, in 1984, had $6.1 billion for such emergencies. Last year alone, when F.S.L.I.C. began wholesale closings, it committed $37 billion in bailouts. Many more thrift insolvencies are expected, and industry experts now estimate that the cost to American taxpayers of all these failures will exceed $100 billion.
ALTHOUGH THE DISASTER at Empire Savings gave Federal regulators their first glimpse of fraud as a major cause of thrift failures, the role fraud played was, until recently, consistently underrated - by regulators, by Congress, and certainly by the savings and loan industry itself. Sagging economic conditions in Texas and euphemisms like ''speculative lending'' or ''imprudent management'' served to mask the seriousness of the thrift debacle.
For the period between 1984 and 1987, according to a Congressional study released last fall, thrift losses due to fraud were placed at $8 billion to $11 billion. At least three-quarters of thrift insolvencies during the same period were linked, by this study, to some significant level of misconduct or abuse.
"It was the most widespread, reckless and fraudulent era in this nation's banking history," says Edwin J. Gray, who presided over the disaster when he was chairman of the Federal Home Loan Bank Board, the nation's chief thrift regulator.
The very mechanics of white-collar crime - the misapplication of the legitimate tools of business - have transformed a sleepy industry into a regulatory nightmare, making fraud hard to define, harder to detect and harder yet to contain.
In Texas, a special fraud task force of 75 full-time investigators - from the Federal Bureau of Investigation, the Internal Revenue Service and Federal regulatory agencies - has been investigating widespread banking corruption from a list of more than 500 names, including large numbers of prominent Texans.
So far, the focus of fraud has been on Texas and California. At times, the hand wringing over the thrift disaster suggests that post-deregulation thrift failures were the result of economic acts of God. But thrifts like Empire failed, for the most part, because those who managed them killed them. And they were able to kill them because deregulation - the national policy that sought to save them - provided the motive, the opportunity and the means.
ON OCT. 15, 1982, RONALD REAGAN strode into the Rose Garden to sign the Garn-St. Germain Depository Institutions Act. Following earlier deregulation legislation in 1980, Garn-St. Germain was the final step in the process of deregulating the nation's federally chartered financial institutions.
The 14,000 or so commercial banks were generally solvent, but the 3,000 or so thrifts were, by all accounts, in terrible condition. Thrifts were spending more than they could collect. High interest rates had forced home lending to a standstill. Mortgage payments from older, low-interest home loans were providing increasingly inadequate income. (Although state-chartered savings institutions virtually obliterated the boundaries between banks and thrifts, federally chartered thrifts were still required to lend primarily for housing, even after Garn-St. Germain.) Deregulation in general sought to restructure savings institutions by allowing them to invest in shorter-term enterprises, including direct investments in real estate, stocks and securities, as well as the ability to make commercial loans. It also allowed thrifts to pay market rates for deposits. What was little noticed at the time was a contradictory effort to strengthen the safety net: the Federal insurance on deposits was raised from $40,000 to $100,000 per account.
"All in all," said the President in the Rose Garden, "I think we hit the jackpot."
The ones to hit the jackpot, however, were not the people the President or Congress or Federal regulators had in mind.
Even before Garn-St. Germain reached the Rose Garden, deregulation was in full swing at Empire Savings, a state-chartered thrift. Operating out of a small shopping center, Empire seemed to be making a fortune bankrolling condominium developments in the I-30 corridor.
Since the late 1970's, state-chartered savings and loan institutions in Texas had been able to participate in real-estate development in precisely the manner envisioned by deregulation. In fact, the performance of deregulated Texas institutions like Empire had been used as a basis for regulatory studies supporting Garn-St. Germain.
When Spencer Blain became chairman of Empire Savings in March 1982, the thrift was a small, sluggish local home-lender. Almost overnight, Blain transformed it into a regional economic force. Between December 1981 and September 1982, loans at Empire more than quadrupled while deposits tripled.
The cash for loans was generated by another creature of deregulation - brokered funds, which are usually large deposits placed by commissioned middlemen on behalf of such cash-rich clients as credit unions and pension funds. By offering higher interest rates - often two percentage points higher than other thrifts and commercial banks - Empire could attract millions. And because of the security of Federal deposit insurance and the efficiency of computer technology, those millions could be generated overnight by brokers.
Empire's startling transformation, however, was inextricably tied to the fortunes of one man - Danny Faulkner.
Even in Dallas, where the making and breaking of millionaires is routine, Faulkner was special.
He was at the center of a condo culture in the I-30 corridor. While high interest rates had brought home-building to a near standstill in other parts of Dallas, real-estate development was booming here because Faulkner, through Blain, made it happen - and he made it happen because he was brash enough and savvy enough to capitalize on the deregulation of thrifts. Each Saturday morning at the Circle Grill, people in fancy cars pulled in early for breakfast with Danny Faulkner, who was noted for his generosity. By late 1982, a roomful of insiders, politicians and would-be Danny Faulkners rang up tabs for as much as $1,000 a week on the Condo King.
Faulkner was an unabashed sort. When his son was married, the Tulsa Philharmonic was hired to play the theme from "Rocky." En route to the north Dallas reception, a uniformed guard stood at the tollway with a large sack of quarters, tossing in the fare for Faulkner's guests.
A rough-hewn developer with a penchant for Rolls-Royces and Rolexes, Faulkner was a sixth-grade dropout from Kosciusko, Miss., and he professed not to be able to read or write. In the 1950's, he picked cotton in Louisiana and Arkansas. In the 1960's, he painted houses in Corpus Christi and Dallas. But by the early 1980's, Danny Faulkner was rich and living in a sprawling ranch home on Lake Ray Hubbard.
Like most developers, Faulkner was a creature of credit. As a painting contractor in the 1960's and 70's, he relied on loans to bridge his business from contract to contract. His first real-estate venture was a collection of small rental houses bought with borrowed money. To cement his relationship with his creditors, he began buying small amounts of stock in the savings and loan associations that lent him money. By 1979 - the year when he built Faulkner Point, his first condominium project on Lake Ray Hubbard - he was part of a group of close friends and associates that controlled, through stock ownership, at least three thrifts, including Empire Savings.
By fall 1982, however, Faulkner was no longer developing his own condominiums. Although he had developed the handful of condo projects along the I-30 corridor that gave the initial impetus to the boom, he and Empire Savings were the source of the inspiration and the cash for the building frenzy. He and James Toler, a former Mayor of Garland, bought land on option and then sold it at much higher prices to condominium investors. Built around the concept of so-called "Faulkner communities," a loosely associated network of I-30 developments, Faulkner began offering to sell and build turn-key projects that defied real-estate conventions.
According to real-estate records, investors put up no cash of their own. In exchange for their signatures, Faulkner and his associates would provide land, appraisals, financing, architectural plans, construction, marketing and sales, and the borrowers became the bank's development partners. Moreover, Empire and the other close-knit lenders provided 110 percent financing, which included a cash ''bonus'' to investors signing the note.
For many with modest prospects, the deal was an overwhelming temptation. In exchange for a single set of signatures, a secretary or a carpenter could become a condominium developer, getting as much as $43,000 in cash from Empire Savings as a bonus. What these investors didn't seem to know, or didn't care to acknowledge, was that the bonus was not a gift at all, but part of the overall money they were borrowing.
Hidden from the investors were the land flips that they were financing. Real-estate documents reveal that a parcel of land, purchased by Faulkner and Toler at a low price, would be appraised at a higher price, often as much as 10 or 20 times its cost. The title to the land would pass from Faulkner to Toler, often through representatives, then to close associates. Each time the land changed hands, the price would spiral upward, until finally the land could be divided and sold to investors at the inflated price. As a result, the unwary investors were obligating themselves to loans for land that was grossly overvalued. At every stage of the land flip, Empire provided the money.
No money actually changed hands among Faulkner, Toler and their associates. Their profits, often millions at a time, were provided from money borrowed by the investors at Empire. Empire was paid interest, commissions and fees from the proceeds of those loans. The borrowers, namely the investors, paid for everything - including legal fees, appraisals, taxes and title costs. Some of these investors took part not once but as many as six times, each ending up with debts at Empire of $12 million or more.
When the loans came due, and investors could not pay, and the land was not worth what was paid for it, scores of borrowers/investors who had greatly exaggerated their personal worth to get their loans ended up in jail. It then became apparent that the ultimate victim of the land flips was not the investor but Empire Savings and Loan, which was drained of all its assets.
SPENCER BLAIN'S RISE IN THE Texas thrift system had been a relatively smooth one. The balding, button-down executive had headed a thrift on the Gulf Coast of Texas before being recruited at the Austin-based First Federal Savings and Loan Association. He was in his third term as a director of the Federal Home Loan Bank of Little Rock, the regional thrift regulator. And because of his tenure in the industry, he was slated to become president of the Texas Savings and Loan League, the state's industry organization.
As president of First Federal, Blain had met Faulkner in 1980, when First Federal agreed to invest in an expansion of Faulkner Point. The next year, when Faulkner and Toler purchased a 69-acre tract across the street, First Federal became a partner, guaranteeing a $3 million bank loan.
But by late 1981, according to a former director of First Federal, the thrift's directors had become disenchanted with Blain for problems associated with a computer-services venture the thrift had started at his urging; and when Blain walked away from his second wife and a failing $3.05 million personal real-estate venture, he and the board agreed to part ways.
In December 1981, as Blain prepared to leave his job at First Federal, Faulkner offered him a post at Empire. Empire's president, S. A. Bieler, was leaving to invest in condominium projects of his own.
Still deeply in debt, Blain moved into a lakeside condo leased from Faulkner. His divorce was negotiated by one of Faulkner's attorneys.
Unknown to regulators at the time (and it was only discovered when thrift examiners combed through Empire's transactions), Blain started purchasing control of Empire from Faulkner and his associates shortly after he arrived in March 1982. To pay for the stock, he borrowed a total of $830,763 from Faulkner and Toler. Five months after he joined Empire, Blain owned more than 67 percent of the thrift's stock, and named himself chairman of the board. In the meantime, Blain had approved at least $40 million in loans for Faulkner-Toler projects.
Like any banking institution, Empire still made money by making loans. But suddenly the perspective was radically different. Where savings institutions like Empire once made money over the long term (from the clockwork conservatism of middle-class mortgage payments), they now made money over the short term (from investments and commissions and fees). The more and bigger the loans, the more and bigger the fees.
In a matter of months, the demand for I-30 condos was dwarfed by Empire's supply of federally insured, brokered cash. Moreover, through its wholly owned real-estate subsidiary, Statewide Service Corporation, Empire was beginning to become a warehouse for I-30 projects, selling participations in Empire loans to other savings institutions, and refinancing loans made by other thrifts for I-30 deals. By October 1982, the land-flip business had become a juggernaut, so efficient that one high-level participant called it "a money machine."
Blain's activities did not go unnoticed by Federal regulators. In October 1982, Federal Home Loan Bank Board examiners appeared for their regular examination of Empire.
Thrift institutions had long had one mission - to provide long-term mortgage lending for single-family homes. But as deregulated thrifts departed more and more from their traditional mission, there developed not only new pressures on the examining process, but a growing impatience with the process of regulation itself.
This was particularly true in the region served by the Federal Home Loan Bank of Little Rock (the bank was moved to Dallas in late 1983), a five-state area that included Texas, Louisiana, Mississippi, New Mexico and Arkansas. Here, where deregulation began in the late 1970's, underpaid and overworked examiners trained in consumer-lending practices were suddenly forced to analyze such complex business transactions as stock mergers, land swaps and development loans.
Before the regulatory system was finally overhauled in July 1985, there were only 116 examiners available to patrol the 510 thrifts under the Little Rock bank. As late as 1984, a new examiner could expect a starting salary of $14,000 a year, $5,000 less than his or her banking counterpart. As a result, turnover in the region was high.
Nonetheless, the examiners scratched hard on Empire's veneer of growth and stability, and what they found did not look good. In their report, the examiners deemed Blain's overconcentration on condominium investments along I-30 a "risky" strategy. His dependence on brokered funds was troublesome, they said. A large number of Empire borrowers owed sums that were beyond Empire's limits. Often, real-estate loan files contained no appraisals. Construction funds were disbursed without proper controls.
The examination was not completed until mid-December 1982, and not filed until a month later. It would be April 1983 before Blain and Empire responded. By that time, Blain had lent at least another $200 million in condo deals.
AS FAULKNER'S I-30 MARKETING APPARA-tus became more complex, so did the land flips. Such was the disdain toward regulation in the newly liberated environment that, even as examiners poked through Empire's books, the thrift's land flips became their most frenzied. Although the transactions appeared to follow perfectly legal business practices, Federal prosecutors said they were fraudulent for several reasons: the real-estate appraisals were inflated; the financial statements of investors were artificially boosted to show greater personal worth, and the same handful of men and women bought from and sold to one another.
According to real-estate records, land purchased in the morning on paper for $100,000 might pass through as many as five different buyers before being sold that same day in small parcels to investors for $1 million in Empire loans. At the beginning of the chain of buyers were Faulkner and Toler or people representing them. At the end of the line were the investors who received up to $43,000 for signing their names to the deals. (Investors were willing to pay the high prices not only for the immediate ''bonus'' but because they were led to believe that what they were paying were still bargain prices.) For instance, on Oct. 6, the day before Federal examiners began their audit of the thrift, its real-estate subsidiary, Statewide, purchased 82 acres on I-30 for approximately $1.86 million, or 52 cents per square foot. The same day, Statewide sold the 82 acres to Faulkner and Toler for $3 million, or 85 cents per square foot. Faulkner and Toler then sold 18.6 acres of the property to one of their associates who, in turn, sold the property - now appraised at $8.50 to $12 per square foot - in seven plots to investors for $5.6 million, or $6.95 per square foot. In one day, Faulkner and associates ended up with approximately $3.74 million in profits, and the remaining 63.4 acres of raw land free and clear. Court records reveal that another spectacular series of transactions in November 1982 generated millions in personal profits for the bankers involved with Faulkner. On Nov. 19, Faulkner and Toler spent $5 million for 117 acres of land along I-30 known as the Greens. In the space of a few weeks, Faulkner and Toler flipped the land through a series of associates, finally selling it to investors in 62 tracts for $47.3 million financed by four savings and loans.
Faulkner and Toler collected an estimated $16 million from the sales. But on Nov. 27, several days after Empire had lent at least $8.4 million to investors in the Greens, Clifford Sinclair, a Faulkner associate, paid Blain $1.4 million in four separate $350,000 checks. In a deposition, Blain acknowledged that the cash came from "the generosity of Danny Faulkner."
In the same series of transactions, First State Building and Loan Association, of Mountain Home, Ark., lent $10.8 million to the investors. Two of the thrift's officers were paid $2 million from the proceeds of the scheme. To hide the transaction, the cash was placed by Sinclair in a secret bank account designated for the "Lucky Two." (In June 1987, one of the men pleaded guilty to criminal charges in connection with the loans.) The cash proceeds were not limited to bankers. Real-estate and court records show a spreading of wealth by Faulkner and his friends. The head of the title company that closed the real-estate transactions received $600,000 in a land flip. The regional head of the Federal National Mortgage Association received a Rolex wristwatch, while his wife - a ''Faulkner communities'' employee - received a Mercedes and a mink coat.
From the December 1982 land flip known as the Fountains, Texas Attorney General-elect Jim Mattox, an old Faulkner friend, received $200,000 in cashier's checks (made out to his sister and his brother), for which, Faulkner later testified, Mattox had done nothing at all.
WHEN THE FEDERAL HOME LOAN Bank Board received the Jan. 12, 1983, report of its examiners, it caused few waves in Washington. The report was transmitted to the Federal Home Loan Bank of Little Rock, which in turn wrote Empire a letter asking for Empire's response.
In the curious dual system that governed savings institutions in 1983, Federal examiners reported directly to Washington. But any supervisory actions that developed from their examinations were handled regionally. For four years, between 1979 and 1982, Spencer Blain had been a director of the Federal Home Loan Bank of Little Rock; in 1982, while the examiners were auditing him, Spencer Blain was chairman of the bank's executive committee.
When a supervisory letter was mailed to him on Jan. 14, 1983, outlining the regulatory complaints, Blain ignored it altogether. He also ignored a second and a third. (In the meantime, he made $14.9 million by selling a parcel of land he had purchased from Faulkner and Toler to close Faulkner associates.) When he finally answered in April 1983, he simply denied that Empire had done anything wrong.
Like any pyramid enterprise, Empire was able to continue only so long as it could maintain a spectacular rate of growth. And once regulators moved to slow Empire's condo loans, the end of Empire was simply a matter of time. In May 1983, the Texas thrift regulator forbade Empire to make any further I-30 land loans. By September 1983, when many of the old loans came due, investors couldn't pay. And in November 1983, when details of the scheme were published in The Dallas Morning News, Empire found it impossible to find new investors. ON THE MORNING OF MARCH 14, 1984, EDWIN Gray, chairman of the Federal Home Loan Bank Board, gathered with his two board members for a staff presentation on Empire Savings and Loan. The purpose was to review the evidence for the proposed closing of Empire, which had suddenly become a fiscal wreck.
Gray had been on the bank board for a year. As a former press secretary for Ronald Reagan during his California governorship and a former thrift executive, he had been an ardent supporter of deregulation. But during his first year with the bank board, he started feeling uneasy about some of the trends that were emerging from his daily reports. In California, Florida and the Southwest - particularly Texas - thrifts were becoming swollen with brokered deposits, which were being converted into questionable loans.
Gray and the board heard the staff statistics. By mid-1983, Empire's assets had swollen to $276 million, most of which were now loans to the I-30 projects. Assets grew to $308.9 million by January 1984, with more than 85 percent of the deposits coming from deposit brokers.
But what shook Gray that morning was a videotape prepared for the bank board by an appraiser who had surveyed the I-30 condominiums.
"I couldn't believe what I was seeing," says Gray, now president of the Chase Federal Bank in Miami. "It was like watching a pornographic movie. I had to turn away." The condo projects, he said, were "half-built, dilapidated, poorly constructed. It was a mess." Gray says he knew the risk to the thrift system presented by such commercial ventures. He knew the problems at Empire. But until that moment, it had all been academic.
''I couldn't believe anything could be so crooked. And then it hit me: What if it was happening somewhere else?''
The scheme, however, had already metastasized. As many as nine Texas savings institutions had lent millions to the I-30 developers, some of them for projects outside the I-30 corridor. Groups of I-30 investors, inspired by the Empire formula, ''did'' deals in other cities in Texas and in other states.
PERHAPS THE BEST MEASURE OF deregulation is the bitter irony of what it has become. Although it had been designed to preserve home lending, its perverse practitioners all but abandoned the home loan in favor of office towers, condominiums and shopping malls. Deregulation was intended to preserve thrift deposits;, instead, it is witnessing record runs.
Deregulation is now a vigorous and necessary reregulation, as Federal agencies become custodians of hundreds of financial institutions, stockholders-in-due-course of bankrupt companies, and owners and liquidators of one of the nation's largest portfolios of real estate, including the I-30 condos owned by Empire Savings.
Having substituted rigid regulations with the laws of the marketplace, deregulation fostered a wave of white-collar criminality that may take another decade to resolve. Instead of saving the thrift system, deregulation has instead raised the legitimate question of whether the thrift system will survive at all.